K12 Inc. Learning Hard Management, Financial Lessons

K12 Inc. is on a remedial course of action after learning hard lessons about managing student enrollment and addressing public criticism about the academic performance of its students.

The Herndon, Va.-based company—the largest for-profit provider of precollegiate online learning and one of the few publicly traded companies in the K-12 marketplace—showed an inability to enroll as many students as anticipated for the 2013-14 school year. That sent its stock into a nose dive earlier this month—a 38 percent drop that also came three weeks after a prominent hedge fund manager, Whitney R. Tilson, took a position that the company was overvalued.

Company management responded to both developments in different ways.

During an Oct. 10 call with stock analysts, K12 Executive Chairman Nate Davis took full responsibility for management issues that left 11,000 fewer students signed up than the company had the potential to enroll. Behind the scenes, founder and CEO Ronald Packard met with Mr. Tilson about the public lashing represented by the Kase Capital managing partner's presentation at a conference in New York last month.

October represents an annual rite of passage for K12 Inc., when the year's overall financial performance can largely be anticipated based on how many students are on its rolls.

This year, 128,000 students are currently enrolled in K12 programs, an increase of 5.7 percent compared with last year at the same time. But Mr. Davis said enrollments were well below company expectations.

Management Challenges

Officials of K12 forecast that their revenues would increase by between 3 percent and 4 percent for the first quarter of fiscal 2014, which is lower than the company's full-year growth, and that K12 would incur operating losses during that period of $8 million to $10 million.

K12 Inc. Stock Plummets

The value of the virtual education company’s stock rose steadily for almost a year before taking a nose dive this month. Some analysts predict continued problems for the country’s largest for-profit provider of K-12 virtual education while others paint a more positive outlook for the company’s future growth.

SOURCE: NASDAQ

The day after K12's announcement, the company's stock price plummeted from more than $29 a share to about $19. At the end of last week, it was valued at $18.60.

Mr. Davis attributed his company's shortfall to these issues: insufficient staffing to handle a 25 percent increase in the number of applications between July and September; the fact that the company did not prepare adequately for new compliance requirements, such as face-to-face meetings before enrollment in one state; management's failure to swiftly adjust staffing in enrollment centers when some school openings were delayed; and a school with 1,500 applicants that did not open at all.

Upgrading school-by-school planning tools to match media and advertising with enrollment periods will be one way the company adjusts, said Mr. Davis.

Mr. Tilson has been one of the company's chief critics. A founding member of Teach For America who is now an investor and an advocate on education issues, he acknowledges that, by law, the company cannot turn students away, but he contends that learning online is inappropriate for unmotivated students, particularly ones who lack parental guidance and oversight at home.

"When K12 was small, it was mostly serving kids like mine, with at least one—if not both—college-educated parents working in the home with children," Mr. Tilson said. "In those cases, it really works."

But after speaking with Mr. Packard and Mr. Davis, Mr. Tilson has changed his opinion of K12's intentions, if not its prospects.

"Prior to meeting Ron, I thought this company was knowingly targeting students who were certain to fail, but didn't care because that was the way to profitability and growth," Mr. Tilson said in an interview last week. Talking to K12's top leaders convinced him it is not "an evil company."

Sector 'Run Amok'

Mr. Tilson's critique of K12 for investors focused on the scrutiny the company has faced on several fronts. One of his arguments is that K12's academic results have been lackluster by too many measures.

"Like subprime lending and for-profit colleges, the business makes sense on a small scale—but, fueled by lax regulation and easy government money, the sector has run amok," he wrote in the presentation he gave.

For his part, Mr. Davis believes that Mr. Tilson's extensive presentation had one motivation: "He's clearly focused on driving the price of the stock down. I think he's gone overboard," the K12 leader said.

Frank A. Bonsal III, a general partner in New Markets Venture Partners, a Fulton, Md.-based early- and growth-stage venture capital firm that invests in education, said large public companies experience growing pains, and he doesn't "put a lot of stock in the shock and awe of reports like that."

A former educator who is now an entrepreneur and venture investor, Mr. Bonsal said he would be more concerned if he saw a compilation of negative reports from K12's customer base. "That's worth downgrading a stock," he said.

Unlike some other stock analysts at the time of K12's announcement about its financial outlook, Trace Urdan, a managing director and a senior analyst at Wells Fargo Securities in San Francisco, upgraded his company's rating of K12's shares after the announcement. He said the prospects for the stock's growth look promising since K12 Inc. hasn't reached the enrollment cap in some states.

"They have another 12 percent of growth without any new cap increase and any new approvals," Mr. Urdan said.

The company has been growing steadily for years, but such growth can cause complications. K12 has faced increasing scrutiny about the academic performance of the students in its programs.

In 2012, the company was sued by a group of investors who claimed they were misled by K12's business practices and academic performance. Earlier this year, the company announced it had reached a tentative settlement of that class-action securities lawsuit.

In a recent court development, Florida Virtual School, a state agency based in Orlando that provides online courses to Florida's school districts as well as to students in other states, had its trademark-infringement suit against K12 revived, after a federal appeals court reversed a lower court's dismissal of the suit.

Florida Virtual School's suit alleges that K12 adopted the name Florida Virtual Academy for its services in the state, used the acronym FLVA, and paid for a sponsored listing on a Web address that was similar to Florida Virtual School's site to divert traffic to its business.

K12 fought the suit, asserting in a court document that the Florida Department of Education was aware of K12's use of trademarks such as Florida Virtual Academy, and "in fact, expressly approved such use." The company also uses "virtual academy" in other states, it pointed out.

About the issue, Mr. Davis said: "I'm not concerned. We never violated anything."

Tom Vander Ark, a board member for the International Association for K-12 Online Learning, or iNACOL, said the association has discovered that online education providers receive many enrollments late, after the first day of school.

"When you look at the performance of those kids, they do significantly worse than returning kids," said Mr. Vander Ark, who writes an opinion blog for Education Week's website.

He said iNACOL has identified "the need for better measures and better enrollment policies so families and kids get better advice when they enroll and better measures of academic growth in these schools."

As K12 Inc. makes adjustments for the challenges of enrollment, company officials said it will also be looking at how to improve student performance.

Finding new ways to engage students from the outset will be a focus. Mr. Davis said the company has just started to roll out an engagement test, giving students a chance to sample the curriculum and the experience of online learning, with the hope that it will show them—and their parents—what taking an online program entails before they begin.

Yet he conceded that monitoring ongoing engagement is a challenge and a frustration.

"For those students who are not engaged, it is difficult to get them out of the program," Mr. Davis said. "In one state, we have to go find the student, and take them to the brick-and-mortar school. Until you go through all those steps, you can't 'unenroll' them."

Plans for Expansion

Mr. Tilson challenged K12 to find a way to determine quickly whether students are not engaged and are simply logging on the minimum number of times required, without actively participating in the program. He maintains that those who are "gaming" the program should be identified and eliminated from it.

He said taking that step would help the company improve test scores, and give those students an opportunity to find a school environment better suited to them.

Mr. Davis said his company will continue to work on expanding its future product offerings, such as making its curriculum more mobile and more individualized so that schools can purchase parts of it. "We'll be selling to districts more and more, and to consumers," he said.

As for the October setbacks, Mr. Davis summed up his company's resolve in the conference call: "We understand that we didn't deliver. This is on us. We've got to demonstrate that we can do better so we can get credibility back in the marketplace. We'll be working hard to get that done."

Contributing Writer Mark Walsh contributed to this article.

Coverage of the education industry and K-12 innovation is supported in part by a grant from the Bill & Melinda Gates Foundation. Education Week retains sole editorial control over the content of this coverage.

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